3. The so-called self-liquidating loans are largely liquid only with respect to individual banks and not to the banking system as a whole.
4. Liquidity is mainly a matter of high organization of the market for credits and of the markets for the various forms of collateral.
Extensions of Investment Credit To the degree that banks invest in stocks and bonds of cor porations, they contribute fixed capital to enterprises. The purchase of securities is the practical equivalent of loaning funds; loans to purchase securities which are then pledged to secure the loans are practically vicarious purchases of the securities. That there is a marked tendency for commercial loans to become con tinuous and permanent is due to the fact that production tends to become more and more capitalistic and continuous operation more and more necessary for efficiency, while improved facilities in distributing products lengthen the period of consumption and reduce the seasonal feature of business. Probably a fifth of com mercial bank loans are now for investment purposes.
The one-time practice of banks of insisting that their borrowers "clean up" their loan account at least once a year has nearly ceased, except in lines of business having one or two definite seasons, and loans are indefinitely renewed time after time, or if borrowers are required to "clean up" they may borrow at one bank to "clean up" at another. Large borrowers sell their notes widely over the country through note-brokers; to pay a lot of notes maturing and due to holders in one section of the country, another lot will be issued and sold either to these same holders or to purchasers in other sections; thus the banking system as a whole supplies permanent working capital. The individual bank, however, may decline to renew a loan or to purchase the renewal paper, and thus not itself provide permanent capital.
When the whole banking system is considered, it is clear that commercial paper is only to a small extent self-liquidating. The banks renew loans freely, as just noted; their regular customers depend upon this accommodation, and large contraction or re fusal to renew loans is quite impossible, especially in time of panic. When a borrower becomes strong enough to borrow through sale of his paper widely over the country and any holder refuses to purchase the renewal paper, he can borrow from other banks. The holder bank may also at any time sell the paper to another bank. Thus rediscount gives liquidity, but rediscount is simply a shifting of assets as between banks and as between forms of assets. One of the specific purposes in developing the federal reserve banks was that of providing central banks where paper holdings of needy banks might be converted into cash funds by this process of shifting assets. The capacity of the federal reserve banks to liquefy by rediscounting comes through their ability to tap unused reserves and to create federal reserve notes, which in the tills of the banks constitute not only a paying medium but also an actual reserve, although not termed "reserve" by the law.
Loan Ratios as Business Barometers The sum of a bank's investments in securities and of its loans and discounts represents its contributions of capital to business. A part of these funds was originally deposited as cash in the bank; the rest have been created by the bank. Bank notes and deposit liabilities have been created and exchanged by the bank for various credit items of borrowers, while the borrowers possessing these bank notes, deposits, or actual government money, have been enabled to procure materials, labor, tools, plant, transporta tion, and the like. The funds put into investments and some in determinate proportion of the loans (and discounts) represent contributions of permanent capital. The proportion of the loans which constitutes permanent advances of capital ranges in all probability from 20 to So per cent. The tendency is to increase.
The ratio of cash reserve to investments, plus, say, 3o per cent of loans, is therefore a measure of the degree to which a bank contributes permanent capital to business. The ratio of cash reserve to, say, 70 per cent of loans, measures the temporary advances. Users of business barometers watch closely the less complex ratios of: (1) cash reserve to loans, (2) investments to aggregate assets, (3) loans to aggregate assets, and (4) the sum . of loans and investments to aggregate assets. The history of the first, third, and fourth ratios is shown in the accompanying charts (Figures 2 and 3), and by subtracting the third from the fourth the second can be obtained. During the war the increase of bank cash reserves in this country did not keep abreast of the expansion of loans, the result being that the ratio of cash reserves to loans decreased precipitately. The loan account developed into an unprecedented state of extension; the banks met the urgent de mands for funds to finance the war and war industries; an ex cessive proportion of the loans was collateraled by United States securities, and did not necessarily represent contributions of working capital to industries. The percentage increase of securi ties, largely United States war securities, purchased by the banks rose faster than the percentage increase of either loans or aggre gate assets. As the purchase of securities is from the bank's point of view in many respects equivalent to a loan to the seller, these large purchases during the war had the effect of increasing the multiple to which banks create a loan fund on the basis of cash reserve. It might be said also that the contributions of per manent capital by banks were in effect increased both absolutely and relatively. Some liquidity was given to the war loans by making paper backed by war securities eligible for discount with the federal reserve banks.