Banking - Trade Acceptances
( Originally Published 1918 )
Within the last year American bankers have favored and to the best of their ability have promoted the adoption of a system of mercantile or "Trade Acceptances" to replace the old mercantile system of open accounts.
The Purpose of this is to free the money held idle in open accounts. It is considered a change necessary to successful war financing. Our trans-actions with our Allies in Europe have grown to proportions so vast that they call for new methods of credit and settlement; and our interior trade is subject to embarrassment by money lying idle through credits being unduly prolonged at home.
Four Billion Dollars Frozen Up. Deputy Governor Treman of the Federal Reserve Bank of New York estimates that $4,000,000,000 is "frozen up" in open accounts, that would become liquid and return to useful activity and kept moving, if Trade Acceptances were generally adopted. This amount is considerably in excess of all the actual money now issued and circulated in the United States. If set free, it would turn itself over several times a year. The result of such a mobilization of money and credit would be to liberate and enlarge the latent powers of domestic trade and at the same time sweep away barriers that heretofore have held back foreign commerce.
A Trade Acceptance May Be Described as a bill of exchange which automatically liquidates itself.
Such bills have for years been handled by Lon-don banks (and by acceptance houses, known as "Merchant Bankers") as the choicest of all forms of negotiable paper. Any London bank or merchant banker can always and without trouble rediscount such paper at the Bank of England. The greater part of England's overseas commerce was financed in this way, both buying and selling; and the vast growth of England's trade with the world was and is maintained by the advantages of the system, its equity and safety, and its automatic release of money from the obstructions and delays that were unescapable under the old methods of sale and collection.
Sterling and Dollar Acceptances. Being in terms of English money, these acceptances were known as Sterling Acceptances. Since through the Federal Reserve Banks the system has been established in this country, Trade Acceptances here are known as Dollar Acceptances. Where transactions are international, they are known in the money terms of the country in which the goods are to be delivered and in which the acceptance is made as Sterling Acceptance, Franc Acceptance, and so on.
Closely Defined, the Trade Acceptance is a negotiable certificate of indebtedness arising out of a current transaction in merchandise. It is confined to obligations arising from a sale of goods, and must have a definite maturity.
The accepted draft may cover various kinds of transactions, and may be made payable on demand, at sight, or at the end of a stated time. It fixes direct liability upon the person or firm possessing title to the goods themselves.
It reduces the cost and simplifies the process of collection, by making collection a detail in the machinery of banking.
It practically liberates the banks from the restriction under which they can loan no more than ten per cent of their capital and surplus to any one man or concern upon single name paper, for the Federal Reserve Bank Act provides that: "Any Federal reserve bank may discount acceptances which are based on the importation or exportation of goods and which have a maturity at time of discount of not more than three months, and indorsed by at least one member bank. The amount of acceptances so discounted shall at no time exceed one-half the paid-up capital stock and surplus of the bank for which the rediscounts are made. That
"The aggregate of such notes and bills bearing the signature or indorsement of any one person, company, firm or corporation rediscounted for any one bank shall at no time exceed ten per centum of the unimpaired capital and surplus of said bank; but this restriction shall not apply to the discount of bills of exchange drawn in good faith against actually existing values. That "Any member bank may accept drafts or bills of exchange drawn upon it and growing out of transactions involving the importation or exportation of goods having not more than six months sight to run; but no bank shall accept such bills to an amount equal at any time in the aggregate to more than one-half its paid up capital stock and surplus."
Method of Procedure
A pamphlet issued by The Mechanics and Metals National Bank of New York gives the procedure of financing exports through the medium of Dollar Acceptances, thus :
"A foreign buyer has bought goods in the United States. The American exporter who sold the goods demands a bank credit against which he can draw when shipment has been effected. The buyer abroad arranges with his local bank for the credit, and the foreign bank in turn requests its American bank correspondent to open a credit in favor of the American shipper, available by the latter's ninety days' sight drafts on the American bank, such drafts to be accompanied by certain shipping documents which are then specified. The American shipper, after having effected shipment and secured the bill of lading and other documents required, draws his draft and presents the latter to the American bank for acceptance, together with the required shipping papers. The American bank accepts the draft, to fall due in ninety days, and returns the accepted draft to the shipper, forwarding the shipping documents by first mail to the foreign bank.
"The foreign bank turns these documents over to its client, the buyer of the goods, against such security as it may see fit. Funds to meet the acceptance on the due date are guaranteed and furnished by the foreign bank to the American bank. This part of the transaction lies entirely between the two banks.
"In the meantime the American shipper, who in payment for his shipment now holds a 'bank acceptance,' either discounts that acceptance with his own bank, or sells it in the open market at what is called 'the ruling rate for member bank acceptances,' thus receiving his money.
"The advantages of the dollar acceptance in this case are obvious: The foreign buyer wants ninety days' time at the lowest cost; this the American seller gives him. Knowing that he can sell the acceptance which he receives from the American bank at the lowest possible rate, he (the seller) adds only a small percentage to his selling price in order to cover himself for this discount. The American seller thus is enabled to quote lower prices than at any time before the passage of the Federal Reserve Act, when he was compelled to draw on some foreign bank, which procedure compelled him to add to his price a good margin to protect himself against loss in exchange, against a higher discount, and against the cost of the bill stamps.
"Bank acceptances may be employed in anticipation of actual exports. For instance : A merchant has a large order for an export shipment; he may, upon having made proper arrangement with his bank, draw long drafts on the latter, using the funds thus created for the purchase or preparation of the shipment. After the shipment has been made, the draft on the foreign purchaser or the foreign purchaser's bank, together with the relative shipping documents, are handed in to the bank for discount or collection, the bank in turn using the proceeds of this draft in liquidation of the original acceptance.
"This method has been successfully used since the outbreak of the war, and due credit should be given to the Federal Reserve Board for its intelligent and practical interpretation of the law."
The same pamphlet tells how a home merchant may use the Acceptance, and gives the case of a buyer who has to meet a draft for $50,000, covered by domestic shipping documents:
"The buyer, having made the proper arrangements with his bank, authorizes the latter to accept the seller's draft for $50,000 drawn upon the bank (not upon the buyer), provided the draft is accompanied by certain specified documents, such as invoices, railroad bills of lading, etc. There are instances when it is more practicable that the customer himself draw upon the bank instead of the seller. However, the other method is the more usual one. The draft is presented by the seller, accepted by the bank, and returned to the seller. The documents are withheld by the bank and turned over to the customer against the familiar trust receipt.
"The seller now has the bank acceptance for $50,000, which he can readily discount in the open market. Thus the actual funds are provided under competition by the banking and investing community at large.
"The procedure to create Dollar Acceptances secured by warehouses receipts or other documents covering readily marketable staples does not vary materially from that outlined, except that the customer of the bank usually does not designate any third party to draw the draft on the bank, but draws it himself.
"The advantages of these acceptances are four-fold :
"First: In case of the seller, he receives his money promptly.
"Second : The bank's customer has obtained his loan (or rather credit) at a lower cost than by the use of the promissory note, the rate for a three-months' promissory note, all other things being equal, being higher than the discount rate for a three months' bank acceptance plus acceptance commission. This difference is eloquently illustrated by the different valuation applied by European bankers to an investment of ready negotiability as compared with one that locks up the funds of the bank.
"Third : The bank is able to accommodate its customer more readily, since it advances only its credit, the ultimate buyer of the acceptance advancing the actual money.
"Fourth: It has a balancing effect on the money market.
"Thus, through the use of the bank acceptance the bank can take care of the needs of its customers without carrying the merchant's paper in its portfolio.
"In other words, the bank, when granting accommodations, is not dependent upon the amount of loanable funds it has available."
ADVANTAGE OVER NOTES
Secretary McAdoo, most of the banks, and many mercantile associations and chambers of commerce, have been urging the substitution of trade acceptances for the old open account. The Irving National Bank of New York has formulated reasons for the change, and states the advantage of acceptances over promissory notes:
The Trade Acceptance
Provides a liquid asset and makes possible a fuller utilization of the commercial credit of the country than is possible under existing methods.
It benefits the buyer because it develops careful buying.
Enables him to keep better track of his out-standing obligations, thereby avoiding the evils of over-extension.
Strengthens his credit and puts him in the position of a preferred buyer.
Develops in him the habit of prompt payment and furnishes him with an excellent reason for requiring prompt payment from his customers.
Enables him to realize that credit is as tangible as cash and should be guarded and used accordingly.
Eliminates wastage and lost motion attending the open book account method.
It is good business because it releases business capital for new transactions.
Improves the chances of the buyer of small means to operate in successful competition with the large buyer.
Helps the buyer to deal always in current transactions rather than in long drawn out book accounts.
As the buyer often becomes a seller, the same advantages that apply to the seller apply to him. Serves as a tonic to the business organizations concerned.
Prevents the accumulation of overdue accounts.
Develops a sounder and more serious attitude toward the buyer's own obligations.
It helps the seller because it promotes the economical treatment of merchandise and enables the seller to do business at a smaller operating cost.
Relieves him from the necessity of selling his accounts at the high rate of interest usually exacted.
Enables him to offer the bank additional security.
Strengthens the seller's financial statement, by showing the character of his accounts.
Enables the seller to gauge more accurately the commercial standing of the buyer.
Tends to confine borrowing to funds actually needed.
The seller inoffensively assists the buyer to complete his contract in the way in which he originally intended to complete it.
Enables the seller to more accurately calculate his collections for stated periods.
Enables the seller to facilitate his customer's business by extension of credit and by deliveries in a way not always possible under the open account system.
Gives the seller two-named paper to present to his bank for discount.
Enables the seller effectively to dispose of the possible necessity of subsequent proof of the legal status of the transaction, and to exhibit for inspection the highest possible class of book ac-counts.
MAKE IT PAY THE BUYER
The trade acceptance is thoroughly established in international transactions, but its use in commerce here at home is growing ;slowly, Many American houses refuse to be drawn upon; a few organizations, like the Ohio Retail Dry Goods Association, have demurred; and many business men and firms cling to the old method of open accounts and note discounts.
B. C. Forbes of New York, one of America's shrewdest and safest writers on business and finance, has treated this feature of the situation in his own publication, Forbes' Magazine. Mr. Forbes says in part :
"High government officials, prominent bankers, financial periodicals, even the daily press, have waxed eloquent over the advantages of trade acceptances to the country, to financing the war, to the Federal Reserve Banks' operations, to the financial institutions, to manufacturers. There has been a continuous chorus in praise of the benefits the new system will bring to everybody —except the man who creates the acceptances, the retailer, the buyer.
Why should a buyer pledge himself irrevocably to meet a bill on a specific date if he can get the goods at exactly the same price on the open account basis? If no advantages are offered hint, why should he grant an advantage to the seller? To do so would be a one-sided bargain.
"Make it financially advantageous to the buyer to accept and see how prompt he will be to do so. You are asking something new, something additional from him. You must give him something new, something additional in return. Put it on a proper business basis. Make it profitable for the buyer to accept. There should be one set of prices, one set of terms for the buyer who accepts and another set of prices, another set of terms for the buyer who refuses to accept and who insists upon having the goods carried on open account.
"Instead of proclaiming daily from the house tops what a lovely thing the adoption of trade acceptance would be from the bankers' viewpoint, let the financial powers that be talk plainly to the sellers of merchandise and prevail upon them to change their selling methods to meet the changed credit conditions or, rather, to meet the change that is desired. It has been too widely assumed that the next move is up to the buyer. The cold business truth is that the next move is up to the seller."
The Promissory Note
The pamphlet issued by The Mechanics and Metals National Bank of New York and above quoted recites that in order to finance his purchases and take advantage of the cash discount, the merchant formerly went to his bank and borrowed on his promissory note such funds as he required. The rate of interest he had to pay varied according to the state of the money market, while the money market in turn always showed the effect of our old banking system, with its lack of rediscount facilities and its consequent tendency to sudden and abnormal fluctuations.
"The advantage to the banker in discounting his customers' trade acceptances instead of his promissory notes, in case his customer goes into bankruptcy, need hardly be enlarged upon.
"Although a promissory note is backed by the entire assets of the maker, including the accounts receivable, these accounts receivable, become part of the assets of the bankrupt's estate, while the holder of the note merely becomes a creditor along with the other creditors. In case of a trade acceptance the holder collects from the acceptor when due, keeping the money, whether or not the drawer in the meantime has become bankrupt."
The booklet of the Irving National Bank (New York) points out that "the promissory note deals with all kinds of business transactions the trade acceptance with current merchandise transactions alone. The trade acceptance is not to be given for borrowed money, or past due obligations."
It adds that the promissory note is "not usually as strong as double name paper, because in the latter case two parties instead of one are responsible; nor so readily negotiable as the trade acceptance, and not conceded so favorable a re-discount rate"; and that it is based upon uncertain or at least undisclosed merchandise value.