5. Difference Between Loans And Discounts

In proceeding to describe how a bank lends money, it will be needful to look at the subject in several ways. Loans may be divided into discounts and purchases of paper. These are not quite the same. A discounted note is one presented by the owner who desires the money for his own use; a purchased note is one presented by a bill broker for a bank to buy. The bank may deal with both notes in the same manner, nevertheless they are distinctly two kinds of paper, and somewhat different principles apply to them. Let us first take notes offered for discount, which it may be remarked are regarded by banks with the most favor.

6. How And To Whom Loans Are Made

Let us also imagine they are offered to a bank in which the board does the discounting, what is the process of dealing with them?

Briefly, a borrower presents a note or copy to the cashier of a bank, or makes known his request, the amount he desires, the length of time, the names of the indorsees, or other security. Also the rate of interest is usually under-stood which the bank will charge if the loan is made. The cashier keeps a book in which all the offerings are entered; it is called the Offering Book. When the board meets the first thing to ascertain is, how much money the bank has to lend. If there is none, of course no applications are granted. Generally a bank has money to lend, and the next thing to do is to read the applications. This is done quickly. Sometimes the applications are not kept in this regular way, but consist of notes or other paper left by applicants for the bank to consider. Again, the offering book is not always kept by the cashier, especially of a large bank, but by some one under his direction, or by a clerk having special charge of loans.

In this way the directors at once acquire knowledge of the wishes of all the applicants, the amounts, the securities they have to give, in short, all the most essential particulars pertaining to their applications. If there is money enough to supply all, and they are deemed worthy, the process of granting loans is very short; a vote may be taken on granting all or a separate vote on each note ; in either ease the work is quickly done. If a director objects to a note, his vote is often sufficient to cause its rejection. It is true that in most matters the majority rule applies, and it ma)' apply to a discount; but in many banks the unanimity rule is in vogue, not always, but generally. To lend money is a serious business; and a bank seeks to minimize the risk. Should a loan be made to which a director for a good reason objected, and the borrower afterward tailed and the bank lost, it would be a reflection on the sagacity of the directors who voted for the loan. They hesitate therefore to make a loan when a director strongly objects and brings forward cogent reasons for declining the risk.

Very often there is not money enough to supply all applicants; though all are worthy, some of them must be disappointed. In such cases by what rules, if any, do directors proceed?

First, a depositor who has a large and regular balance is first preferred. He is a good customer of the bank, his account is valuable, and should be first served. The bank seeks to return his favor by rendering the greatest favor in return by giving his paper preference over all others.

Second, the notes of a smaller and less valuable depositor are generally preferred to those of an outsider. He is served on the same principle that his account is worth something, therefore the bank should seek to do more for him than for an outsider to whom it is under no obligation.

Third, security is an important matter. Between two applicants possessing unequal credit or security the bank grants the application of the stronger applicant.

Fourth, the rate of interest which an applicant is willing to pay maybe the turning consideration. If one applicant is willing to pay a higher rate of interest than another, and offers a note well indorsed or otherwise secured, though it may not be quite so well secured, his application may nevertheless have the preference. If the security is ample, the bank may be willing to incur the risk for the sake of the higher interest.

Sometimes the applications of outsiders or important customers are granted at a temporary loss or detriment to a bank for the sake of future gain. A former president of the Second National Bank of New York told the writer that at one time the Erie Railroad kept a small deposit in his bank, and its principal deposit in another. The money market became depressed, rates of interest quickly rose, and many individuals and corporations suddenly found themselves in trouble to borrow money. The president mentioned knew that in a short time the Erie Railroad would be in need of a large amount of money, and he collected a supply to be ready for the unusual demand. When the president of the railroad appeared and made known his wants and inquired to what extent they could be met, he was promptly told, to his great delight, that the bank would lend him the entire sum. The consequence was that the railroad made the Second National Bank its principal depository of money, which was the end the president had sought to attain.

Another principle that sometimes comes into operation in lending by national banks is the reserve limitation. Every bank in a reserve city must keep at least one half of its reserve at home in cash, and every bank in a central reserve city must keep its entire reserve, or twenty-five per cent of its deposits, in cash. If a bank happens during any emergency to have drawn down its reserve below the legal limit, it must cut off loans until the deficiency is made good. Of course, as borrowers are constantly discharging their loans, the effect of not making new ones is, the reservoir fills up, and as soon as there is an excess loans can be resumed.