PROVISION FOR LOSSES BY BANKS.

Daily Telegraph (Napier), 16 February 1883, Page 3

PROVISION FOR LOSSES BY BANKS.

(Scottish Banking and Insurance Magazine.) One of the most important phrases constantly occurring in bank reports is that which usually accompanies the statement on the amount of net profit .made- during the period under review. The City of Glasgow Bank, occupying' as it did tin exceptional position among banks, latterly dispensed with the practice ; but it is tin almost invariable rule to declai'c the profits as ascertained " after provision for all bad and doubtful debts." Where this assurance is not given attention should at once be called to thcomission. There are great differences, however, in the practice of banks in making such provision. While it is a rccoghised costom to make an estimate of prospective losses, and to deduct from tho profits the amount so required, some banks probably err in minimising their loss. There is a great temptation to this in the case of young bunks, even in cases where the general management may be otherwise good : and, of course, where bunks have got into a weak condition, the temptation is still stronger. In the case of old-established and wealthy banks, a contrary course is usually followed. It is felt as a relief to cut out all doubtful business when ascertaining the position of the establishment. In this way it often comes about that excessive provision for losses is made. While this may seem to infringe the rights of the proprietors, it is truly the wisest course that can be followed. The position of a bank should always be actually better than it is represented to be by published statements. An invisible reserve is thus created, which in times of pressure forms an admirable buffer between the bank and the public.

The reserve fund is often called a provision for losses. It is so undoubtedly. Before the capital can lie encroached on, it must disappear. But it should very nirely iicc-uv that any deduction from the reserve fund requires to he made. When such a transference is made, a bank's credit is unuudoubtedly injured iv somewhat the same way as if its capital were reduced. Iv point of fact, the accumulation of a reserve fund is in one sense an increase of capital. T dividends are not paid on it nominally, it is at least earning profit which permits a higher dividend to "be paid on what is technically called the capital. _If, then, a reduction of the reserve fund is injurious to the credit of a bank, it is right that special care should be taken to avoid such a contingency. But bad debts are inseparable from the business of banking. Consecuion'tly they should be regarded as a necessary part of the business, aud treated accordingly in the general business management. Unfortunately, however, bad debts in banking experience arc like comets in the solar system. Wlule they may be expected with absolute certainty, the time and manner of their arrival, their number and their magnitude, are usually involved in impenetrable uncertainty. Considerable periods may elapse without any material loss emerging. At other times losses occur with irksome repetition. There are times for small losses. and times for big ones. Careful management will, of course, minimise the amount of loss experienced; but it often happens that the strongest banks suffer very seriously. The case of the London and Westminster Bank is a case in point. With more than £30,000,000 of assets its directors have sometimes been able to say that no loss of any consequence has been made during half-a-year's business. And yet to those who remember the time of the arch-swindler Collie some ten years ago, such statements recall a startling experience, which has long since been recovered from, and which »:ve'n at the time was borne with case owing to the ample provision made previously for unusual contingencies, but which were accompanied with very serious anxiety and grievous loss. But while it is right year by year to lay aside privately from profits a sum sufficient to cover all nnfurscen possible losses, there is another class of losses which should be provided for in the same way. These are the unforseen losses—those which are not expected, but inevitably come. It is, for the most part only iv good years that thu can be douc. If " not done when losses are agreeably conspicuous by their absence, it becomes necessary it do it when profits are small aud 3oss:es aro numerous. In other words, bank profits should bo estimated not by the year,

but by tens of years. The profits, in excess of the average gained in good years, Avill thus make up for the deficient profits of bad years. Such a policy as this has a splendid 'effect on the credit of a bank. When it is seen to ride out a financial storm Avithout losing a spar, it is regarded with almost boundless confidence. It is. moreover, too often forgotten by shareholders that profits reserved are not lost to them. The money still remains their property, is probably in safer keeping than in their own, is earning profits for them, and is insuring them from future danger. These remarks arc applicable to other businesses than banking. Had such a policy as Aye are here advocating been followed out by property investment companies, their present experience would in all liklihood have been avoided. To the public it Avoidd all along have seemed as though their profits Avere on a moderate scale : consequently, there Avould haA'e been less specula tii'e business. When the bad times came they Avoidd have been able to meet their losses Avithout such apparent serious consequences as have been seen. It is a safe rule for all companies trading on credit to dispense entirely with sauguineuess, to estimate profits as less than they appear to be, and to treat losses as larger than they are likely to prove.