The Future of the Discount Market

ON the occasion of the recent annual Banquet given by the Lord Mayor to the merchants and bankers of the City of London, the Governor of the Bank of England, in the course of a brief speech, touched upon one or two points which although, perhaps, scarcely noticed by the general public, are of considerable concern to bankers and to the financial community. In the early part of his speech Mr. Norman referred to the vital need for an increase in international trade and in our export trade, and then a little later he made the following observations :

" They had in the City of London a form of banking which had come to be called merchant banking. That, alongside the particular and peculiar' traditions and experience built up in London, was what they all inherited from their forbears. Let them remember that. The business of merchant banking, or whatever they called it, showed a curious development. It was a case of from the dealer to the merchant, from the merchant to the exporter, from the exporter to the merchant banker, and from the merchant banker to the banker proper. There was no concern in the City of London called by the name of bank which was not interested in that side of the trade. That was the international side which in particular had been inherited by them, and was the great peculiarity of the City of London. There was also the Stock Exchange, and that essential link and cog in the machine which they called the discount market, which had invented and brought to perfection a side of business peculiar to the City of London and unknown practically in other places, which worked in with those other ancillaries to banking without which the City of London

would never have reached the position of international c nee which it undoubtedly had reached."

- EFFECT OF THE WAR.

The Governor was obviously referring to the serious extent to which the functions of the London Monev Market have been disorganized as a consequence of the War. The disorganization has arisen out of the great upheaval in normal international trade and trade relations, an upheaval which has greatly reduced the volume of exchange billS which for generations played a great part in the mechanism of the London Money Market and which contributed so largely to Lohdon's prestige as the financial centre of the world. Broadly speaking, this decrease in the supply of bills has been due, first, to a curtailment of international trade itself,' and, secondly, to the fact that so many of the Aransactions are now based upon direct exchange operations inde- pendent of the bill.

TREASURY BILLS.

To some extent, and especially during the years immediately following the War, the place of these bilk of exchange was taken by the enormous volume of British Government Treasury Bills, which at one time amounted to about £1,200,000,000. This substitution of the Treasury Bill for the Exchange Bill, although for a time it gave large profits to the Discount Market, with the complete absence •of risk, was a mixed blessing, for it meant that with the passing of years this large pro- portion of Treasury Bills, involving no risk whatever to the holders, caused the market to have less need for its old skill in discriminating between the credit represented by the various exchange bills, a discrimination which had come to be almost a fine art. Not only so, but by reason of this stupendous volume of Treasury Bills, the Government also began to play a dominating part in the London Money Market in the matter of influencing rates, &c., and this, together with other international influences which need not be set out in detail, no longer enabled either bankers or discount houses to make their usual calculations as to the course of money rates based upon a study of the Foreign Exchanges and other dis- cernible factors.

REDUCING THE TREASURIES.

Obviously the Government could not contemplate with equanimity a continuance of this huge amount of floating debt represented by Treasury Bills, and, quite naturally and properly, measures were taken gradually to fund these obligations, so that today the present total of about £830,000,000 represents a huge shrinkage from the maximum figure, and this shrinkage has not been offset by an increase in the supply of ordinary com- mercial bills. Not only so, but of the present total of Treasury Bills something like £350,000,000 must also be deducted as applicable to the Exchange Equalization Fund and therefore not available for the employment of funds in the Discount Market, while large amounts are held by Public Departments.

FAMINE IN SHORT TERM BONDS.

Moreover, in addition to the funding of Treasury Bills the Government has also funded very large amounts of its short-dated Bonds, with the result that just as the investing public has experienced a famine in the supply of investment securities giving a reasonable rate of interest, so the Discount Market, which is confined to the choice of comparatively short-dated stocks, has also experienced a famine to an extent which, if continued, must inevitably exert a serious effect upon their profit- earning power. Until recently the difficulty has been partially overcome by the discount houses jobbing in fairly short-dated maturities and also, probably, by their holding a greater proportion of long-dated stocks than is strictly consistent with the functions of a discount house. With each fresh advance in prices of the long- dated stocks, however, not only does the interest yield decline, but the risk of capital depreciation increases, while the constant funding of short-term maturities into longer dated stocks increases the difficulty of the Discount Market in finding employment for its resources.

FUNCTIONS OF THE DISCOUNT HOUSES.

The Governor of the Bank was quite right in emphasiz- ing the need for the preservation of the Discount Market as one of the most important cogs in the machinery of the London Money Market. From the point of view of the joint stock banks the Discount Market has always formed one of the most suitable and most desirable directions for the placing of a portion of its resources in the shape of short loans, while in times of real activity in international trade with a corresponding volume of exchange bills, the expert knowledge of the Discount Brokers has been of the greatest use to the banks in their purchase of bills for their own portfolios. Obviously, therefore, a return of international trade activity, which from the standpoint of every country is greatly to be desired, is a matter of special importance to this country, and to the London Discount Market in particular. It must not be supposed, however, that the matter is one in which the London Discount Market alone is concerned, for a return to the old conditions producing a great volume of exchange bills would be conducive to a growth in our own foreign trade, and if that trade is to revive and is to be run on sound lines the functions of the Discount Market are as important as those of the joint stock banks themselves.

DOMESTIC BILLS.

Unfortunately, owing to the innumerable exchange restrictions and tariff barriers which have come into being during recent years any revival in international trade is likely to be a slow process, and, therefore, the practical question arises whether in the interval anything can be done to stimulate the creation of bills as a credit instrument even for domestic trade. In this direction there is no doubt that bankers might do much by familiarizing their customers with, and encourag- ing them in, the use of the bill in place of the direct loan. I know it is often urged that the merchant and trader has a kind of prejudice against the bill, even though at the present time, owing to the low discount rates, it should be cheaper to borrow in that form than by way of overdraft or loan. Nevertheless, there is much to be said in favour of using every possible means to stimulate the use of the bill for domestic transactions. As regards the old International bill of exchange it will, of course, require more stability in the matter of international currencies and exchanges before that great instrument of credit can come into its own once again. Sooner or later, however, it seems reasonable to believe that chaos in exchanges will give way to some kind of order and that gradually we shall see, if not a return to the pre-War conditions, at all events a greatly extended use of the bill of exchange as an instrument of international credit.

HOLDING THE FORT.

From what has been said it must not be supposed, however, that the Discount Market has failed to come out of its ordeal successfully. The reverse is true. So far it has emerged, if not with flying colours, at all events with the flag well hoisted, for the leading companies have not only maintained profits and dividends, but what is, perhaps, even more important, have also maintained balance-sheets showing great strength and liquidity. Nevertheless, in these matters one has to look far ahead and, as I have tried to explain, the difficulties with which the market has been confronted have been of a cumulative and progressive character. And it was doubtless this long view of the situation, with an appreciation of the many impediments in the way of a speedy revival in international trade, which prompted the Governor of the Bank to take the oppor- tunity at a gathering of the leading bankers and merchants of the City of London to emphasize the great importance which attaches to the functions of the Accepting Houses and the Discount Market. They were timely words and will be remembered in the days to come when the Discount Market has returned to more normal conditions.

ARTHUR W. KIDDY.