The London banker is informed that the credit is drawn against him and the letter is sent to the mer chant in India, who proceeds to ship the goods. The merchant insures the goods and puts them on board ship or train. With his insurance certificate, bill of lading and letter of credit he then goes to his local banker and sells a draft drawn against the London bank. The incident is closed so far as the shipper is concerned.
The draft with all papers attached is next sent to London where the Indian bank is credited and the New York bank debited for the proper amount. If the draft is drawn at, say, four months' sight, it is expected that Duggan will hand his New York bank the funds within four months after the draft is ac cepted in London and that, in turn, the New York bank will put the London bank in funds. Duggan gets his goods and has four months from the date of "acceptance" in which to pay for them. He may be able to sell them and take his profits in that time. Of course, the goods cost him a little more when bought with credit than if he paid cash.
7. London's part.--Why carry the transaction thru London in such a round-about fashion? First, a draft on Duggan would not be good in India; sec ond, a draft on the New York bank is not as good as a draft on the London bank. The dollar draft is not as good as one in sterling, because ordinarily it must be held until maturity before it can be realized upon. Since there is no discount market in the United States, it is not readily salable in case of emergency.
The intention here is to show how the letter of credit is used, not why we must go thru London or some other foreign financial center. The reason will appear as the reader gets further into this book and more particularly when he comes to the study of foreign exchange. American banks do make accept ances now on their own account, but the volume of this business can never be great until we develop a discount market in which accepted drafts can be readily sold.
8. Items in us now examine the nature of the bank's liabilities.
29. For present purposes, the items which concern capital stock, surplus and dividends unpaid need no further comment, as they were discussed suffi ciently in the preceding chapter.
25. Each national bank is required to pay a Fed eral tax on its average outstanding circulation, equal in amount to one-fourth of one per cent each half year on such notes as are secured by the deposit of the United States bonds bearing interest at two per cent per annum. The tax is one-half of one per cent each half year on notes which are secured by bonds bearing a higher rate of interest. National banks are also subject to certain other taxes. These taxes are often provided for by monthly accruals.
26. Interest accruals are provided for in the same way 27. National bank notes will be discussed in the chapter on the National Banking System.
28. The item "due to banks and bankers" consists primarily of three kinds of claims. First, banks out side of New York City are accustomed to deposit a part of their required reserves with some bank in New York. State banks in New York do this regularly by permission of the state law. National banks located outside the three central reserve cities—New York, Chicago and St. Louis—were permitted under the National Banking Act to deposit a part of their legal reserves with national banks which were ap proved as reserve agents. The Federal Reserve Act required that these reserve deposits be withdrawn gradually and placed either in the banks' own vaults or with the Federal Reserve banks in the various dis tricts, all to be withdrawn by the end of 1917. At the time of this statement, reserve city banks—na tional banks located in reserve cities—were permitted to carry four-fifteenths of their required reserves on deposit with approved reserve agents in central re serve cities; country banks—all national banks outside of reserve and central reserve cities—were permitted to carry one-fourth of their legal reserves on deposit with approved reserve agents in either reserve or cen tral reserve cities.
Second, banks all over the country carry balances with New York banks against which they draw drafts for exchange purposes.
Third, at certain seasons of the year excess cash is also deposited with New York banks which can always make use of the funds for call loans in Wall Street.