This section is from the book "Banking And Business", by H. Parker Willis, George W. Edwards. Also available from Amazon: Banking and Business .
Consideration has thus far been given to the methods which a bank may follow in establishing a sound portfolio. This policy is determined not alone by the judgment of the banker, but also by a certain amount of government control which seeks to maintain the liquidity of banks in general. Government regulation of loans takes the form either of absolute prohibition of certain types or of conditional restrictions of others. The specific provisions of the National Bank Act are designed to forbid the granting of loans which imperil the safety or liquidity of the bank. A national bank is not allowed to grant a loan collateraled by its own capital stock, nor can it purchase its own shares except to prevent loss on debts previously contracted. Real estate may be owned by a national bank only if the building is used for its own business or if the property has been acquired through the nonpayment of debts on the part of borrowers. The bank must dispose of such property acquired through default, for the stock must be sold within six months and the real estate in less than five years.
Of greater significance are the legal restrictions imposed on loans granted by national banks. These regulations enter into the daily transactions of every national bank, and their content should be known by business men who receive loans as well as by bankers who grant them. These restrictions limit the various classes of loans in the following respects: (1) amount to one party, (2) aggregate amount of any one class of loans, (3) value of collateral, (4) maturity of obligations.
The system of independent banking which prevails in the United States has developed mainly banks of small size and there is frequently a tendency for single borrowers to receive loans entirely out of proportion to the resources of the lending institutions. As a result a bank at times holds an excessive amount of obligations due from one business enterprise, and so the welfare of the former may become entirely dependent upon the fate of the latter. The bank's safety can to some extent be insured through wider distribution of its credit risks, and so this policy is encouraged by legislation limiting the amount which a bank may lend to any one person, firm, or corporation. This limitation is usually expressed in the form of a ratio between the loan to the borrower and the capital investment of the bank. For example, the National Bank Act does not allow a loan to one interest in excess of 10 per cent of the bank's paid-up and unimpaired capital and surplus. By including the surplus in this ratio a larger extension of credit is thus permitted than if capital alone were taken as a basis.
Another set of restrictions is imposed not upon the amount of loans to single borrowers, but upon the aggregate amount of certain classes of loans which are limited to a definite proportion of the bank's capital and surplus. The total of such classes of loans to all borrowers must not exceed the entire amount of the bank's capital and surplus.
Another method of enforcing the principles of safety through government regulation is to insist that a bank in granting certain kinds of loans shall receive collateral which offers an adequate margin. This value in excess of the loan will vary with the character of the collateral. If its marketability is restricted, its value is necessarily limited, and the bank must protect itself against loss by requiring a relatively larger margin.
These limitations on the lending powers of banks have reference mainly to their safety, but to insure their liquidity is also essential, and therefore another form of government restriction confines the maturity of certain classes of loans to specified periods of time. Consideration will now be given to the four classes of restrictions as they are applied to the following obligations: (1) promissory notes, (2) acceptances, (3) real-estate loans.
 
Continue to: