This section is from the "Practical Banking" book, by Albert S. Bolles.
There is another side to this story, also. When a bank obtains circulation and loans the money derived from it in a community, the people in the region are helped. The wheels move round a little faster, and I do not know but that a bank is entitled to some share of the profit, if it takes all the risks of men's business, their tricks, their honesty, and their frequent failures. Very certain it is, that if the banks did not issue their notes the people could not issue their notes as they do at present. We will now leave this branch of banking, and see how our National Bank of Commerce makes money in another direction, and at the same time serves • the people. I refer now to the loaning of money. What money has a bank to loan? 1. It has its capital. But, in the case we have supposed, instead of loaning its $250,000 paid-in capital, it will only have $188,100 to loan, which is the amount of circulating notes received from Washington, in exchange for its bonds bought with all of its capital. 2. The bank really loans its whole capital to the Government by its act of buying $250,000 bonds, drawing four per cent, interest, so that the bank receives four per cent on this amount, as well as what it can make on its circulation. 3. It has its deposits to loan; that is to say, after reserving what is a prudent amount for the ordinary calls of its depositors, it can invest the balance in such a manner that it can be relied upon in case of need.
Experience teaches the bank manager how stable or how unreliable his balances may prove. In an old and well-established bank, perhaps two-thirds of the deposits may safely be loaned, on various lengths of time and various kinds of securities. In a new bank, or in a poor bank, the officer will not be surprised if his balances are as unstable as his own power to and his dealer in an emergency. These three, then, are, in the main, the sources of means for a bank to loan and make money:
1. The capital. 2. The circulation. 3. The deposits.
Let us next see how the loans are made. What can our National Bank of Commerce loan upon? In walks Mr. H. He says he wants to hire $2,000, and will give as security his son Bill and his farm. He is told that the National Bank of Commerce cannot loan on real estate, as the law practically prohibits it. Whereupon Mr. H remarks that he would like to know of what earthly use banks are if a man can't raise money on a good farm and on his son Bill's backing. But he is reminded that farms won't pay debts, and that in loaning money belonging to other people care must be had that the money can be easily forthcoming when the debt is due. Mr. B presents a note by a man up in Baldwin, indorsed by the man's wife and by Mr. Jones of the same town. Inquiry fails to bring out the fact that Mr. Jones and the rest of the Baldwin family have any intention of paying the note when due; but shows that they want to hire the money to help build up a cheese factory. Now, while a cheese factory is a glorious institution, yet it is not the thing for a bank to loan its money on. In other words, banks are not established to make permanent loans, but to buy notes on short time, given for the actual purchase or sale of goods.
In country towns the practice differs. For instance, if there was a bank in Bethel, in this State, the drover would present a note signed by himself and three neighbors, and would want to hire for three months $2,000, so that he might go through the towns picking up cattle, and pay his note when he got through the operation. So, also, another man would hire money outright to buy hay and dried apples, and still another would want a thousand or two to fit out a winter logging crew. Back of all these transactions is the apparent ready ability of the hirers to pay their debts out of the commodities dealt in. The money is not tied up in a farm or a cheese factory as a permanent investment.
In cities the trader brings to the bank a batch of notes given for goods sold to country traders. There is a value received in every note. Flour, molasses, sugar, oil, pork, have passed out of the store in the city, and the "note expresses the value. The dealer in the city wants to use his capital over again, and so sells his notes to the bank. The bank buys the notes, and gives the dealer a credit for the same upon his bank book.
In New York and some of the larger cities still another practice prevails. Merchants have a way of making their own notes and selling them outright at the price of money at the time. This can only be done by the strongest houses. Other houses go to the bank and say, you have for collection on our account a considerable number and amount of notes; now, hold these as security, and loan us a certain amount on our note. This is all legitimate, as you will see that the bank has abundant security on hand in a form that can easily pay a loan.
Still another method is that used largely in the Western States. I refer to the buying and selling of exchange on eastern cities. A man picks up a customer for 200 barrels of flour. The flour is ground in Minnesota, for instance. As soon as it is ready for delivery he puts it aboard the cars and gets a railroad receipt or bill of lading, showing that 200 barrels of flour have been put into such cars, shipped to Mr. Jackson, at Portland. The bank in Minnesota says that he can pin his bill of lading to the draft he is about to make on Mr. Jackson, and the bank will purchase the bill. The bank does not depend on Mr. Jackson's credit, for they instruct their correspondent in Portland not to give up the bill of lading until they get their money. This custom is confined to the West and South, and arises from their large sales of produce in the East.
The profit made by banks on their loans is the interest for the time that the note or draft has to run from the day it is bought by the bank till it matures. Who gets the profit ? The stockholders, of course. The capital is divided up into shares, generally of $100 each. Twice a year the directors look at the balance sheet and say that, after paying the salaries and the taxes, they can pay a certain amount to the stockholders. But one old director remarks that they must first add to their surplus account an amount that the law prescribes before they can divide. The idea of the banking law is to make the public safe; so it is wisely provided that until the surplus of a bank is fully twenty per cent, of its capital no dividend shall be paid until at least one-tenth of its profits shall be added to the surplus.
There is another little trouble that sometimes prevents the stockholder from getting a dividend as he expects. A bank, like a merchant, loses money, sometimes, after exercising the greatest care and the best judgment, and saying "No, no, no," over and over again.
Sometimes a man dies, and everybody is surprised to learn that the estate cannot pay its debts. The bank holds his paper with only a fair indorser. This fair indorser can't respond to so much calamity, and so he fails. The bank settles off and loses fifty per cent, of its debt. Or, a fire burns a man's store and stock, and he is inadequately insured; the bank loses again. Or, what is worse, and what makes a bank man mad (and justly so, too!) is when a firm lie, telling all sorts of stories about their business and profits and expenses, and the community wake up some fine morning and find the bubble collapsed ! ten cents on a dollar and nobody to blame.
The feeling of reciprocity between banks and their dealers ought to be encouraged. The banker is interested in the success of his dealer. He sees a great many accounts, and he can be of much aid to the merchants in exposing tricks and extended credits, and the peculiar ways of men who deal with the merchants. The merchant should feel that the banker is his friend, that if he criticises it is from good motives. For instance, here is a young man just starting in the wholesale grocery business. He is ambitious to do all the business that he can, and probably tries to do more than he ought to. In his anxiety he strikes out for new accounts, and sells some country traders very large bills. He takes their notes and carries them to his bank for discount, where he is kindly told that he is selling such a man too much for his good, and the bank declines his paper. Now, the banker notices that another concern is working hard to shove that customer off, and this ardent young man may get a big load before he is aware of it. I can recall very many cases where merchants would have saved many bad debts if they would but have taken a hint kindly given.
Young merchants especially ought not to attempt sharp practices on their banks. Fictitious balances, or balances arranged so as to look well the last day of a month, and exchanged checks, and a thousand and one little sneaking ways, only hurt a merchant and destroy his credit. The banker's ledger generally shows a continuous balance, varying with each transaction; averages, and not "put up jobs," show the value of an account. My judgment is, that there is now but very little "shaving" and "grinding" exercised by the bank towards the borrower. Nor is there any disposition of this kind in respectable quarters. Money is an article of merchandise; it has its price; its price varies like the price of sugar and flour. Firms of undoubted credit can hire money lower than can some others of lower credit, just as ready money and a sharp buyer can buy 100 barrels of flour cheaper than a man who purchases on four months and is slow pay. It is true that banks do not discount all the paper that is brought to them. Nor are they bound to. They have the right of choice as much as a merchant has whether he will trust out a bill of goods.