The total number of banking houses of this kind in the United States is not great. Of about 4000 offices, at the time of writing, in some way dealing in securities, practically all are brokerage offices of one kind or an other. The membership of the Investment Bankers' Association of America includes most of the banking houses eligible for mem bership. Financial qualifications for mem bership are that the applicant shall be en gaged in buying and selling securities on its own account and shall have a capital of at least $50,000 engaged in this business. With a capital of less than $50,000 a banking house could hardly enter the field of corpora tion finance in any way to deal directly with the corporation. At the time of writing the membership of the Association comprises 340 main offices and 176 branch offices of these houses. Practically the entire organ ized business of financing the capital ac count of our corporations centers in these houses. The total number of branch offices is undoubtedly much greater. The branch offices listed as members have, most of them, considerable autonomy in managing their affairs.
Probably most readers will be surprised that the amount of capital necessary to qualify for membership in the Investment Bankers' Association is so small rather than that it is so large. People are likely to as sume from the magnitude of the transactions undertaken that the business must require the banking house to have a large capital. But the business does not require a large capital tied up in plant like a manufacturing organization. The investment banker is en gaged in dealing in credit and requires capi tal only as an assistance in commanding credit. When the banker supplies the cor poration with capital, he receives the cor poration's securities at the same time. how much of the capital the banking house must advance itself and how much it can borrow on the transaction depend on the nature of the securities, the position, senior or junior, that they occupy in the corporation's plan of capitalization, and, especially, whether they are of a kind to command a relatively quick and close market. Depending on these conditions the banker can borrow from 50 to 90 per cent of the money necessary to complete the transaction of purchasing the securities from the corporation. Though the loan will rarely be so small, in actual practice, as 50 per cent, the lender produces the same effect by insisting on mixed collat eral and by accepting only a percentage of slow and wide market securities as collateral for a loan.
A reader entirely unfamiliar with finan cial transactions may wonder where the in vestment banker borrows the money. He borrows at any national bank, state bank, or trust company ready to undertake the business. Since the banks located in the financial districts naturally get the business of the dealers in securities, they come to be known as "financial banks." Instead of financing commodities in the course of con sumption, they are, so to speak, financing securities in the course of consumption; that is, in the process of sale to the capitalists who commit their funds to the enterprise of the corporation issuing the securities.
The bank in making the loan primarily con siders the marketability of the securities put up as collateral. It is of the first importance to the bank that its loans should be liquid.
That is why, from the standpoint of a bank, it engages in the business of financing com modities in the course of consumption. As the commodities pass from one stage to an other of the process of consumption, of mar keting and use, the loans fall due and are re paid. If the bank can get an equally liquid loan in any other way it is just as good bank ing for it to do so. One danger lies in loaning on securities. Prices for the securities are very sensitive to credit and other market conditions and vary widely with general business conditions. Security prices fluctu ate more widely than commodity prices. Panic conditions may make them not liquid at all. If the bank, however, takes as col lateral securities with a quick market and watches the changes in price, it engages in thoroughly sound banking. The market ability of securities, however, varies widely, and ordinarily a bank would not require that all of its collateral for loans should have as quick a market as the most active stock exchange securities. The investment banker knows that he will have no difficulty in getting a loan on his active collateral. He wants to get accepted as collateral as many of his inactive securities as possible. Neces sarily the investment banker must get some of his collateral released from time to time as he proceeds with the sale of the securities, and substitute other securities in the place of those released. He may endeavor to get less active collateral accepted on these sub stitutions. If he meets with any success, the process is known by the expressive term of "milking the collateral." The amount the bank will advance on the security of given collateral depends on the marketability of the collateral just dis cussed and on the possible or probable range of fluctuation in the market price. A bank would probably make a larger loan on the security of a good municipal bond than it would on the security of most very active high-grade railroad bonds. Though the mu nicipal bond would not have as active a mar ket as the railroad bond, the probable range of price fluctuation within a short time is not so great. In the same way a bank would not loan as much on stock collateral with the most active stock exchange market as it would on a well-secured bond with a good but much less active market. A bank might loan as much as 95 per cent of the market value of the very best municipal bonds and as much as 90 per cent of the market value of high-grade active railroad bonds, when it would not loan more than 75 per cent of the market value of an active stock. A which makes a business of loaning on finan cial collateral of this kind must, of course, keep in the closest possible touch with the market for securities and watch the fluctua tions in prices and their bearing on the loans of the institution.