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Unformatted text preview: nd lax regulations. As a result, some S&L operators wrote very high interest rate, but
very risky, loans using low-cost, insured deposits. If the loans paid off, the S&L owners would get rich. If they went
into default, the taxpayers would have to pay off the deposits. Those government policies ended up costing taxpayers
more than $100 billion. Choosing a Bank 27-23 on a business to liquidate its loans when the firm’s outlook becomes clouded,
whereas others will stand by the firm and work diligently to help it get back on its
feet. An especially dramatic illustration of this point was Bank of America’s bailout
of Memorex Corporation. The bank could have forced Memorex into bankruptcy,
but instead it loaned the company additional capital and helped it survive a bad
period. Memorex’s stock price subsequently rose from $1.50 to $68, so Bank of
America’s help was indeed beneficial. Specialization
Banks differ greatly in their degrees of loan specialization. Larger banks have separate departments that specialize in different kinds of loans—for example, real estate
loans, farm loans, and commercial loans. Within these broad categories, there may
be a specialization by line of business, such as steel, machinery, cattle, or textiles.
The strengths of banks are also likely to reflect the nature of the businesses and the
economic environment in the areas in which they operate. For example, some California banks have become spets in lending to electronics companies, while
many Midwestern banks are agricultural spets. A sound firm can obtain more
creative cooperation and more active support by going to a bank that has experience and familiarity with its particular type of business. Therefore, a bank that is
excellent for one firm may be unsatisfactory for another. Maximum Loan Size
The size of a bank can be an important factor. Since the maximum loan a bank can
make to any one customer is limited to 15 percent of the bank’s capital accounts
(capital stock plus retained earnings), it is generally not appropriate for large firms
to develop borrowing relationships with small banks. Merchant Banking
The term “merchant bank” was originally applied to banks that not only made loans
but also provided customers with equity capital and financial advice. Prior to 1933,
U.S. commercial banks performed all types of merchant banking functions. However,
about one-third of the U.S. banks failed during the Great Depression, in part because
of these activities, so in 1933 the Glass-Steagall Act was passed in an effort to reduce
banks’ exposure to risk. In recent years, commercial banks have been attempting to
get back into merchant banking, in part because their foreign competitors offer such
services, and U.S. banks compete with foreign banks for multinational corporations’
business. Currently, the larger banks, often through subsidiaries that engage in investment banking activities, are being permitted to get back into merchant banking, at
least to a limited extent. This trend will probably continue, and if it does, corporations will need to consider a bank’s ability to provide a full range of commercial and
merchant banking services when choosing a bank. Other Services
Banks also provide cash management services, assist with electronic funds transfers,
help firms obtain foreign exchange, and the like, and the availability of such services
should be taken into account when selecting a bank. Also, if the firm is a small business whose manager owns most of its stock, the bank’s willingness and ability to
provide trust and estate services should be considered. Self-Test Question What are some factors that should be considered when choosing a bank? 27-24 Chapter 27 Providing and Obtaining Credit Summary
This chapter discussed granting credit and the conventions for interest rates on
bank loans. It is important to monitor the results of credit policy by monitoring
accounts receivable. A firm can affect its level of accounts receivable by changing
its credit and collections policy, but doing so also affects sales. Therefore, a complete analysis of the effects of changes in credit policy is necessary. The key concepts covered are listed below:
A firm’s credit policy consists of four elements: (1) credit period, (2) discounts
given for early payment, (3) credit standards, and (4) collection policy. The first
two, when combined, are called the credit terms.
Additional factors that influence a firm’s overall credit policy are (1) profit
potential and (2) legal considerations.
The basic objective of the credit manager is to increase profitable sales by
extending credit to worthy customers and therefore adding value to the firm.
Firms can use days sales outstanding (DSO) and aging schedules to help monitor their receivables position, but the best way to monitor aggregate receivables
is the payments pattern approach. The primary tool in this approach is the
uncollected balances schedule.
If a firm eases its credit policy by lengthening the cred...
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