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The determinants of bank borrowing under the finance act, 1914-1934 Kerr, Erik Sven

Abstract

The Finance Act (1914-34) provided the chartered banks with rediscounting facilities. During World War I, these facilities became part of the banks' regular means of cash adjustment. Subsequently, a controversy arose whether or not the chartered banks rediscounted for private gain. In defence of the banks, Sir Thomas White stated that the banks always borrowed sparingly because of the wish neither to incur the cost involved nor to be heavily indebted to the Treasury. The purpose with the thesis is to test Sir Thomas’ hypothesis. In order to do so, the hypothesis had to be revised; that is, the difference between the rate charged for advances and the cost of alternative means of adjustment (the least-cost spread) was substituted in the hypothesis for the simple cost determinant. By the use of indifference curve analysis, certain criteria for testing the hypothesis were developed and used in testing data for borrowing by the aggregate as well as the individual banks. The evidence showed that the revised hypothesis was overgeneralized both in its description of the banks’ use of the Act and in its explanation of the causal relationships. Thus, in terms of both volume and duration of borrowing, the facilities of the Act were used extensively by several banks. Both the least cost spread and the aversion to be indebted appeared to be crucial determinants of borrowing. The strength of the relationships, however, varied significantly among the banks. In particular, for the more conservative banks, the aversion to borrowing was strong at any level of indebtedness. For the other banks, the aversion was apparent only at levels of heavy indebtedness.

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