of the four months the draft drawn by the Canton firm and accepted by the London bank falls due and the New York banker must remit funds to meet it. If before the draft matures the Paterson concern has not met its obligation to the New York banker by prepayments as the silk is manufactured or sold, the banker will send it a memorandum of the amount due, which will be the face of a demand draft at the ruling rate of sight sterling plus the banker's commission. The Paterson firm sends a check for the amount. The New York banker then buys demand exchange on London and remits it in time to cover the maturing draft in London, thus closing the entire transaction. We have already noted the advantage to both the importer and the exporter in the use of the commercial letter of credit. The banker's interest in the transaction is one of commission. The New York banker gets a commission from the silk importer, and the London banker on whom the credit is issued gets a commission for accepting the drafts. Yet neither banker has had to put up any actual money, the whole operation being based upon the banker's credit. 124. The foreign exchange department. The rapid extension of our foreign trade and the increasing numbers of Americans traveling abroad has resulted in a demand for wider banking facilities to handle international transactions. Formerly this business was largely in the hands of a few private banking houses, but the great increase in foreign business resulting from the war and the broadened facilities afforded by the Federal Reserve Act for handling foreign credits has led many banks and trust companies to establish foreign departments. As the foregoing discussion shows, the chief business of the foreign department of a bank is to deal in foreign exchange in its various forms. The larger banks and private banking houses have a foreign exchange manager who is a specialist in that business and who keeps in touch by telephone, wire and cable with money and exchange conditions both at home and abroad. Then there are the big dealers in exchange who do a regular exchange business like the banks, but who also have men out on the street trading between large buyers and sellers of bills and keeping in touch with exporters, importers and other banks. Finally, there are a very large number of exchange brokers who bring buyer and seller together, charging a commission for the service. 125. Foreign operations of Federal reserve banks. The Federal reserve system affords Federal reserve banks and member banks greatly enlarged facilities for engaging in foreign exchange transactions and for promoting international trade. In the section of the Act relating to open market operations, Federal reserve banks are authorized "to purchase and sell in the open market cable transfers and bankers' acceptances and bills of exchange of the kinds and maturities made eligible for rediscount, with or without the indorsement of a member bank." They may buy from member banks and sell commercial bills of exchange; deal in gold coin at home or abroad; and establish foreign agencies to deal in foreign bills of exchange arising out of actual commercial transactions. National banks having a capital and surplus of $1,000,000 or more were empowered, subject to the permission of the Federal Reserve Board, to establish branches in foreign countries, and, by a subsequent amendment, to invest ten per cent of their capital and surplus in one or more American banks or corporations principally engaged in international or foreign banking. Under the original Act member banks are authorized to make foreign acceptances, that is, to accept drafts or bills of exchange growing out of the export and import of goods having not more than six months to run, and Federal Reserve banks are permitted to discount such acceptances when indorsed by at least one member bank and when within three months of maturity.1 By an amendment passed in 1916 member banks were further empow1 By an amendment to the Act the acceptance privilege was extended to domestic acceptances. ered to accept three months' drafts drawn upon them by foreign bankers "for the purpose of furnishing dollar exchange as required by the usages of trade" in foreign countries. Such drafts or bills may be acquired by Federal reserve banks subject to regulations by the Federal Reserve Board. Dollar credits. Of the many radical changes in the operations of international finance wrought by the European war none has been more important to the American importer than the introduction of "dollar credits," that is, bills of exchange drawn upon American banks in terms of dollars as distinguished from those drawn upon foreign centers in pounds sterling or other European currency. Prior to the war the great bulk of our importations were covered by credits created by drafts drawn in pounds sterling on London; rarely was a draft drawn in dollars on New York. The service provided by foreign money centers in furnishing us with the necessary credit facilities costs us millions of dollars annually in interest, commission, etc. As a result of the expanded facilities for financing foreign trade provided by the Federal Reserve Act, including foreign branch banks, the foreign acceptance privilege, etc., coupled with the dislocation of the machinery of foreign exchange in the financial centers of Europe, dollar credits came into large use during the war. Not only does the importer find dollar credits more economical than sterling or continental credits, since the commission cost of insurance is lower, but he eliminates the risk of fluctuating exchange, as dollar credits are payable in dollars on a given date and no question arises as what the sterling rate may be a few weeks or months later.1 By these and other provisions of the Act of 1913 and its amendments the management of foreign exchange operations will be greatly improved; exchange will be furnished at less cost to the business community; gold movements will be brought under more effective control; American banks will be given opportunity to compete for foreign 1 During the war sterling bills fluctuated at times from $4.50 to $7,09, business on even terms with European banks; and American foreign trade will be afforded ample assistance. READING REFERENCES Clare: A B C of the Foreign Exchanges. Harris: Practical Banking, Ch. XVIII. Margraff: International Exchange. Phillips: Readings in Money and Banking: Chs. XVII XVIII. Willis: The Federal Reserve, Ch. XIV. Withers: International Finance. CHAPTER XVI LOANS AND DISCOUNTS 126. Loans. As stated in a previous chapter the chief business of the commercial bank is making loans through the purchase or discount of commercial paper. In exercising this function banks perform their most useful service to the business community and make the most profits for their stockholders. Attention has been drawn, also, to the close relation existing between loans or discounts and deposits. The bank's loanable funds come mainly from deposits and deposits arise largely from loans. These two important functions of the commercial bank are commonly associated in the term "discount and deposit." In describing how a bank lends money, or more exactly, lends credit based upon its resources in money, it may be well to note the theoretical difference between loans and discounts. Banks discount paper for their customers; they buy the paper of others, commonly through the medium of note brokers. When a bank discounts the note of a customer his account is credited with the amount of the note less the "discount," that is, the interest or charge for the use of the bank's credit; the amount of the note purchased from an outsider, on the other hand, is paid for by check or draft, and at maturity the sum repaid will include the face of the note and interest. Though the latter transaction does not usually create a deposit in the bank buying the note, a deposit is created in some bank in which the check or draft is deposited. This explains in |