At some branches large advances are made on collateral notes. Customers whose business consists of the manufacture, or sale, of farm implements, pianos, organs, sewing machines, quite frequently borrow in this way. They bring to the bank the notes given them by their debtors, and instead of having them discounted they lodge them as collateral for direct loans made to them by the bank. Generally, the loan is less than the amount of the notes pledged as collateral. In technical language the bank has a margin in the collateral security for the loans. The margin may be ten, fifteen, twenty-five per cent., or more, according to the extent of the customer's requirements and to the nature and class of the security he gives. Thus, if a borrower has a loan of $20,000 secured by collateral notes with a margin of 20 per cent., it means that the collateral notes he has deposited to secure his loan amount to $24,000.

Why Notes Are Taken As Collateral

Notes are taken as collateral security instead of being discounted, sometimes because the bank does not rate them high enough to advance on them in full, and sometimes because the customer does not wish to borrow the full amount on them.

When the manufacturer of, or dealer in, the goods just mentioned, effects sales to his customers he quite commonly splits the consideration into several instalments, sometimes with six months or a year between instalments. A note is taken for each instalment. The notes will probably be drawn in a form to give the seller of the goods a lien on them while the notes remain unpaid. Because of the protection he gets through the lien the seller will sometimes give credit to people not possessed of much means. Among the notes taken, therefore, are quite a number not falling due for a year or more; a certain proportion of the whole will be signed by parties whose standing is indifferent or doubtful. And, perhaps, they are all lien notes. When he takes them to the bank these points all will come up as obstacles in the way of the bank's discounting them outright.

But if his credit is good, and his financial position satisfactory, the owner can easily make arrangements with the bank whereby it takes the notes from him as collateral and lends him a certain percentage of their total.

Though a considerable proportion of the collateral notes taken by the banks are inferior in quality to the regular discounted bills, it does not follow that any particular collateral note or notes is inferior as such to discounted paper. It may happen that a customer holds a note bearing the most excellent names, and thai he wishes to borrow only a part of the amount for which it is drawn. The simplest way is for him to lodge the note as collateral to his own note for such a sum as he wishes to use.

Definition Of Collateral Notes

The younger bank officers are sometimes puzzled as to the exact status of the collateral notes. It is easy to understand that the collections are the property of the people for whose account they are held, and that the discounts belong to the bank. But the collaterals have some of the properties of both the others.

Perhaps the best way to explain their status is to liken them to a farm or other property on which a mortgage has been placed. A property that has been mortgaged is in the hands of the party who advances money on it. He has title to the whole property, and can retain it till his advance is repaid. The mortgagor, or one who mortgages, has the equity in the property; which means that he owns all of it over and above the portion required to satisfy the mortgage. The same with collateral notes pledged as security for a bank loan. The bank has title to all the notes pledged. The pledger owns the equity in them.

Needless to say, the banks whose practice is the best give to the collateral notes they hold the same degree of attention as that given to discounted bills. The head offices do their best to combat the disposition sometimes shown at a few of the branches, where the officers regard the collaterals as being of lesser importance. The point insisted upon is that the bank has advanced money on these notes, as much as could be advanced upon them, that it is the duty of the officers to handle them just as attentively and carefully as the discounts, and to do their best to collect them and to keep them in good shape. Where laxity is most likely to occur is in the treatment of past due collaterals. These are sometimes allowed to accumulate till a considerable part of the security held against a current loan is past due. One of the dangers is that a promissor, whose note is past due, may have settled it direct with the bank's customer, and he have neglected to turn in the payment to the bank. Though the bank holds the maker of the note liable so long as it holds the note, it might experience considerable difficulty in forcing him to pay the amount a second time.