Adequate Flow of Credit Vital to National Progress
BUSINESS & INVESTMENTS
A. W. BLUE
Hundreds of thousands of dollars are lost annually in Canada through careless investment. Fraudulent and worthless securities are being constantly poured on to the market to trap the unwary. A general observance of this simple maxim will assist in the reduction and elimination of this economic wasteemdash;
"BEFORE YOU INVESTemdash;INVESTIGATE”
CREDIT, rather than actual money, is the great motivating force in business and industry. It is estimated that fully ninety per cent, of the business of Canada and the United States is done on credit or the instruments of credit. The credit of a business enterprise is one of its most valuable assets, and at the same time one of the most perishable, if constant care is not taken to preserve its integrity.
The farmer who buys a herd of cattle to feed and fatten through the winter, borrows from the bank to finance his contract. The manufacturer borrows to pay for the raw materials he uses in his business. The tradesman borrows when he lays in a new stock of goods and retires his debt when the goods are sold and the money available. A houseowner rarely has sufficient money with which to pay for his home outright. He advances what is convenient and borrows the balance. Even in retail merchandizing the credit system is making deeper inroads, as credit departments, charge accounts, and like systems are in almost universal vogue among the retail enterprises of the Dominion. In fact, the principle of instalment buying has been much discussed of late, and grave fears and warnings expressed in view of its widespread application.
But we are not concerned with this latter aspect of the credit system, so much as with the former. Credit has been described, and with truth, as the life-blood, the motor of business, for lacking adequate resources for credit or the machinery for distributing credit, the business of the country would languish and wane. General progress would be impossible, for the company which has sufficient funds of its own to finance ail its operations, is the rare exception.
Short Term Credit
'THE chartered banks of the Dominion 4 are the agencies for supplying short term credit to business and industry. The latest government report indicates that the commercial banks of the country are carrying $2,138,000,000 on deposit, representing the savings of hundreds of thousands of Canadian citizens. The banks receive these funds in the form of deposits in varying amounts, ranging from one dollar to hundreds or thousands of dollars. The banks are thus the main depositaries of the country’s savings. They, in turn, are constantly subjected to requests for loans for business purposes, and these funds are loaned out where it seems advisable, and where there appears every likelihood that the borrower will be able to repay on time. The funds accumulated from the public are thus kept in employment, and used in the creation of new goods or wealth, or facilitating the movement of goods already fabricated to the ultimate market or consumer. The commercial banks perform a vital service in the life of the country.
The chartered banks now number ten, as compared with thirty-four at the beginning of the present century. This reduction has been effected through merger or failure of operating units. The ten banks now functioning control some four thousand branches, distributed throughout the Dominion, with one or more branches located in every centre of any consequence at all. There is practically no part of the Dominion, unless it be particularly isolated, that is not served by a branch of a Canadian chartered bank. According to the last government report, the total assets of the banks amounted to $3,301,689,567. Savings deposits total $2,138,011,000, and short-term loans amount to $1,315,864,292, and call loans $554,745,000 The banks are carrying $486,464,000 in securities, accumulated during the recent years of easy credit. It is significant of the increased commercial demand that the security holdings of the banks are being steadily reduced, having stood at $532,843,000 a year ago. Capital and rest account of all banks totals $256,331,000.
Funds must be Liquid
r“PHE great bulk of the money employed by the banks comes from depositors. These depositors are constantly withdrawing money or making new deposits, so that the banks must be prepared at all times to meet any number of withdrawals and legitimate demands for credit. Funds must be kept liquid, or constantly flowing in and from the banks, and at all times available to meet legitimate demands, whether from depositors or from borrowers. It is obvious, therefore, that banks cannot issue long-term credits, no matter how attractive the rates of interest. They are subjected to very definite regulation in this respect. Most loans run for thirty, sixty or ninety days. Longer terms may be arranged under special circumstances, but the borrower must be prepared to liquidate his loan within a reasonable time, or sacrifice his standing with the banks which he should be so jealous to safeguard. Loans must be so arranged that there is a constant stream of funds flowing back to the banks, in order that a degree of liquidity essential to commercial welfare may be preserved. If the bulk of the resources of Canadian banks, for instance, were tied up in five-year loans, it is apparent that the freedom of movement back to the banks would be greatly hampered, resulting in an insufficiency of funds to meet the demands for short-term credit on business account. Such a course of action would defeat the primary object for which the commercial banks were established.
An Ontario farmer buys a herd of unfinished cattle in the fall. He has a quantity of feed on hand, and he believes that by feeding and fattening throughout the winter he can sell to advantage'in the spring. But cattle cost money, a good deal of money, and the average farmer is
not prepared to tie up his own funds over the winter. He approaches his banker, and a loan is arranged for the whole or a substantial portion of the purchase price. The following June or July the farmer believes that his cattle have attained the ultimate degree of fitness, and he accordingly sells them. Out of the proceeds he repays his loan to the bank. The cattle, in turn, are sold to the packer, who likewise borrows, and reimburses the bank when the cattle have been converted into meat and finally sold.
The same practice applies in every line of business, whether in manufacturing, retail distribution, or in the basic industries. Each individual step in production or manufacture is aided by credit from the commercial banks in the manner outlined. The manufacturer may lay in a large supply of raw materials. He finances the purchase with money borrowed from the banks, to be returned to the bank with interest when the product has been manufactured and sold. Such a process requires a limited time only, from several weeks to three or six months, and thus the bank is assured of the early return of its funds. As each step is finished, loans are repaid and new loans are made for the succeeding step, if there is one. The entire process of producing raw materials, fabricating them and distributing them to the consumer may be financed on credit obtained from the banks.
Of course, the banks demand security for their loans, and this security is usually the goods or commodities purchased or produced, coupled with the character and business integrity of the interests requiring the loan.
Lending on Security of Real Estate
ID UT _ business as well as private in-
_ dividuals often require other than strictly short-term loans which come directly within the province of the chartered banks. The farmer may wish to buy a new farm or add to his existing land-holdings. The urban dweller may purchase a new house. In neither case, even if the funds are available, will the purchaser desire to make payment in full. The usual method of financing real estate transactions is part payment in cash by the new owner, and the balance borrowed for a period of years, with interest at six or seven per cent., giving as security a first mortgage on the property. There are companies which engage in the business of lending money on the security of real estate, and they are known as loan and trust companies. Real estate loans are usually for a five-year period, and are renewable at the end of that time. Such companies were formerly known as building societies, but ultimately their scope was materially broadened, and today, loans are made on the security of farm land, urban property, a building in the course of erection, or on the finished property. New construction is largely financed by the loan companies, and lacking their constructive co-operation there would be little or no incentive for the owning of, or investment in real estate. Such companies secure thei> funds for loaning, either through the receipt of moneys on deposit or the issuance and sale of debentures. There is no endeavor to preserve the liquidity 0 *unds that the banks strive for, as an altogether different field is served. The insurance companies, annually in receipt o millions of dollars in cash, also loan on mortgage to a limited degree.
The Investment Banker and His Duties
^pHERE is still another financial department of major importance. Within the past two decades there has developed in Canada a branch of bankmg, known as investment banking, which serves all forms of business and public enterprise in a very important and special manner.
We have seen that the commercial banks can lend money to a manufacturing concern to finance a productive process. This is a short-term loan which must be discharged within a period of a few months at the longest. An industrial firm may have a further use for money. It may desire to buy new machinery, to build a new mill, or add an extension to the old one to care for expanding business. Money used in such construction is tied up indefinitely, even up to the life of the construction, and, accordingly, the company must look to other sources than the chartered banks or the loan companies, the latter being limited to fiveyear loans, for the revenues it requires.
Furthermore, municipal governments have need of long-time credits in order to build schools, water-works, sewers, paved streets, roads, hospitals, drainage-works, etc. These are ultimately paid for out of taxes, but the taxes in any one year are not sufficient to meet more than a mere fraction of the cost of local improvements. If a municipality endeavored to discharge each year’s obligation for local improvements out of taxes, progress would of necessity be extremely slow, or an intolerable burden would be placed upon taxpayers. Rather long term credit is employed as in industrial construction, and a portion of the annual taxes is utilized to reduce this debt from year to year.
The investment form of banking has been created to meet the demand for long-term credit, and this type of business has reached an advanced stage of development and efficiency in Canada. Its function is to assemble surplus capital and supply it in the form of long-term loans for business or public needs.
A government or municipality issues its bonds or debentures with which to raise funds to finance some special undertaking. A corporation may issue its bonds or preferred or common stock for similar purpose. These bond or stock obligations are destined eventually to reach the investors of the country who exchange their surplus capital for these interestor dividend-paying securities. Neither a government nor a corporation has the facilities for selling its securities to the investing public. That is not their business. That is where the investment banker steps in. Through years of experience every investment house has established a broad clientele of investors which can be readily reached and approached with a new security offering. The issuing firm, whether it be a government or an industrial corporation or a public utility, appreciates this fact, and negotiates with one or a group of investment houses for the sale of its securities. It is customary for the investment banker to purchase outright an issue that has been subjected to his rigid inspection, and which he believes he can safely recommend to his clients. The issue, whether it be stock or bonds, then becomes his property, his commodity, for sale to the public. His profit is the margin between the purchasing and selling price, less selling costs. The investment banker is virtually a merchant, selling his goods—in this case investment securities—to the investing public. He is distinguished from the broker who merely buys or sells on commission.
To gain some idea of the long-term credit requirements of the Dominion, it is interesting to refer to the record of public financing for the last two years. In 1928, the total of government, municipal, corporation and railroad financing in Canada totaled $440,000,000 as compared with $617,000,000 in 1927, and $573,000,000 in 1926. Of last year’s total, $186,000,000 was on government account; $27,642,000 municipal; $275,000,000 corporation, and $49,000,000 railroad. It will be observed that the corporation total greatly exceeded all others combined. The various issues contributing to these totals were sold to the investors of Canada, the United States and Great Britain, and the
proceeds used for productive or refunding purposes.
The investment banker is charged with the responsibility of protecting the interests of his clientele, and for that reason he is keenly critical of every issue that is presented to him; and if thoroughly conscientious and scrupulous he will pass by the offering that does not measure up to the most exacting standards. He builds up his business by securing the good will of the public and, if once he sells an issue that ultimately “goes bad,” he has a lot of lost ground to recover.
Thus, through these several agencies, the savings and the surplus capital of the country are diverted to channels where they are kept in a state of constant employment, and national progress is stimulated. Lacking these facilities for credit, the country’s economic activities would slump to a very low ebb.