This section is from the "Practical Banking" book, by Albert S. Bolles.
Sometimes a country merchant will draw on a merchant of New York, and obtain thereon a discount at some country bank. The draft will have some months to run before it will become payable; but when it is payable, the New York merchant will obtain the means of payment by drawing on the country merchant, payable some months thereafter, and getting a discount thereon in New York. Such transactions are termed " kiting." They are practiced on notes as well as on drafts; and by persons residing in the same place as well as at distant places. When practiced by persons who live at a distance from each other, the operation is usually very expensive, by incidental charges of exchange and collection. Bankers should suspect the solvency of parties who resort to expedients so commercially disreputable. The real character of the transactions is rarely avowed by the parties inculpated in the practices; but a vigilant banker will soon suspect the operations, and not touch them unless the security can be made very ample.
A country produce dealer, or manufacturer, will sometimes place in New York an agent on whom to draw; or he may connect his operations with some person there of no capital, whom he will use as an acceptor. Such acceptances are no better than the note of the country dealer. They constitute, moreover, a hazardous class of paper, as you may rely somewhat on an assumed capital in the acceptors. Such methods are rarely practiced except by persons who want to extend their operations beyond a limit to which a real consignee would restrict them. No prudential limit exists with the dummy acceptor, hence, the drawer is able to carry his operations to an extent unlimited, except by his own will, or his ability to find lenders; and men thus predisposed, and supplied with the requisite machinery, usually extend their speculations till they are overwhelmed in ruin.
Notes and drafts are often made to be sold at a usurious discount, by parties ostensibly solvent, but who are struggling to purchase a transient respite from bankruptcy, or to amend their fortunes by desperate enterprises. Banks are, therefore, usually reluctant to discount paper offered by brokers and other persons who are known to practice usury; for though usury laws have been greatly modified within a few years, yet no bank wishes to take paper which may form the subject of a lawsuit. In many places the defence of usury is said to be so discreditable that few men will avail themselves of it. In the country, people feel less fastidious in this respect, and any debt which can certainly be avoided by means of usury would be very apt to be uncollectable.
But the avoidance of loss is only a negation of evil. To make gains is the proper business of a banker, and, as the principal source of legitimate gain is lending money, the bank must lend to the extent of its ability—erring on the side of repletion, rather than of inanition; for a banker knows not how far his bank can bear extension till he tries; hence, if timidity, indolence, or apathy, limits his loans in advance of necessity, he may injure the community by unnecessarily withholding pecuniary assistance, and injure the stockholders by unnecessarily abridging the profits. A banker must not, however, extend his loans regardless of the future, but, like a skillful mariner, he should see an approaching storm while it is an incipient breeze, and meanwhile carry all the sail that will not jeopardize the safety of his charge: governing his discounts, at all times, more by the condition of his funds, and his own prospective resources, than by any reputed scarcity or abundance of money in other places and in other banks.
If a banker can make reasonably good profits on his capital without much expansion, he may keep more restricted in his loans than a banker should who is less favorably circumstanced. Every banker must, however, remember, that to be strong in funds and rich in profits are natural incompatibilities; hence, the more money a banker wishes to make, the poorer in funds he must consent to become. In banking operations, as in most other, wisdom lies in a medium between extremes; and if a banker can keep funds enough for practical safety, he had better forego excess of funds, and receive an equivalent in gains. Physicians say that the human body can bear excess of food better than deficiency. The excess can be discharged by cutaneous eruptions, as we see sometimes in overfed infants; but deficiency of nourishment will not relieve itself; so in banking, a repletion of loans, if they are undoubtedly solvent, prompt and short, will soon of themselves work a relief to the bank; but a paucity of loans cannot, by any process of its own, cure the scant profits of the stockholders. Banks are rarely injured, therefore, by an excess of discounts. When banks fail, their disaster proceeds from the quality of their loans, not from the quantity.
No banker should keep his funds inactive when no better excuse exists therefor than that the business he can obtain is not so lucrative as the business of some other place, or as his own business was at some other period. The legal rate of interest is so high, that the voluntary forbearance of its reception for even a short period, is ordinarily a greater evil than the reception of any common description of solvent loans. Any way, a banker who keeps his funds inactive, to await the offer of loans more lucrative than simply the interest of money, should be well assured that the future loans will be sufficiently lucrative to compensate for the forbearance. But no disadvantages of position must be deemed a sufficient apology for the assumption of hazardous loans. When no safe business offers, no business should be transacted by a banker who entertains a proper respect for himself, or a proper feeling for his stockholders. Gains may be impossible, but losses are measurably avoidable. If any location presents the alternative of no business, or great hazards, a banker is accountable for the choice which he may make between the two alternatives; and he is accountable no further.