This section is from the "Practical Banking" book, by Albert S. Bolles.
In negotiating paper note-brokers sometimes endorse it. Follet, whom we have previously mentioned, guaranteed all the paper he sold, and thus became contingently liable for a very large amount. It was said at the time of his failure that the banks which bought it did not do so on his guarantee, but on the credit of the makers of the notes. A bank president at that time remarked, "If a man were to guarantee the note of the richest man in New York, he would be contingently liable for its payment, but the note would be valuable because the maker was responsible. Follet's transactions were very large, and he handled the paper of some of the best firms in the city. I presume the banks of the city are now buying a million dollars of paper a day from brokers, all bought because the maker is supposed to be good, and not because the broker endorses it."
It may be added that banks do not buy paper of the brokers in preference to discounting that of their depositors; but as we have previously said, these institutions are often unable to loan all their resources to persons who make a direct application for money. Banks must therefore either resort to the note-brokers, or loan in some other way.
This bought paper, as it is termed, is entered in a discount book, separate from the Dealers' Discount Book, and for distinction the bought-paper book is called Cashier's Discounts. Cashier's Checks are given for the paper purchased, and each day the total payments of the Cashier's Discounts are credited to the " Cashier account" in the ledger. Each check when presented and paid is charged to cashier's account, which offsets the corresponding credit. Paper discounted for dealers is posted in a Dealers' Bill Book, with a title page for each dealer. Paper purchased is posted in a Cashier's Ledger, with a title page for each name on the strength of which the paper is bought, and both books, of course, are indexed. A reference to any name can therefore readily be had, and the amount on hand, if any, at once be ascertained.
The officers, therefore, may tell at a glance what, and how much of any name bought, they may have on hand. Many banks have lying on their president's desk a small book, the leaves of which are made of silicate slate, with two or three leaves for each letter of the alphabet. The names of paper purchased, with the due dates and amounts, are written in pencil on the appropriate pages, and the entries are corrected daily by erasures or additions, as the case may be.
Some banks have adopted a very perfect system of recording the information they obtain concerning the paper they buy. Books are prepared with a page or more devoted to each name. Here are recorded, briefly and succinctly, condensed extracts of mercantile agency reports, extracts from letters that may be received relating to the character and responsibility of the house in question, synopses of conversations with merchants, bankers, and others who have been found to know the firm, &c, &c. A voweled index affords means of speediest reference to any desired name.
Although the buying of paper has long been practiced by the banks, the Supreme Court of Minnesota, in 1872, declared that a bank which was authorized by statute "to carry on the business of banking by discounting notes, bills and other evidences of debt," had no authority to buy paper.* The custom of buying paper has not been shaken in the least by this decision. It has been practiced too long and extensively to be overthrown by anything except a legislative enactment.
* Farmers and Mechanics' Bank v. Baldwin, Banker's Magazine, vol. 31, p. 630, and seethe same volume, p. 510, for a discussion of the subject.
A common way of lending is on collateral security, that is, on bonds, stocks, warehouse receipts and other evidences of property. Within a few years the banks in the large cities have increased their loans of this nature enormously. They have done so partly because the purchase of paper from note-brokers has proved so hazardous. Within two years mercantile failures have occurred, from which some banks lost heavily in consequence of having large amounts of bought paper. One failure was that of a leather house, whose principal office was in Boston. The banks did not suppose before the failure that the house was floating such an enormous amount of paper. By making their notes, and giving them to note-brokers to sell, it was exceedingly difficult for others to form any judgment of the amount made and negotiated. After that failure, many banks concluded that if loans were made on collateral security their risk would be diminished. They believed that they were quite capable of judging accurately of the value of collaterals offered as security. Many of these loans are made on call, that is, the bank can demand payment immediately, or after one day's notice. Loans on railroad securities as collaterals are regarded with favor by some of the most conservative banks.
The New York Stock Exchange will not list any kind of stocks or bonds unless the instruments or evidences of them are engraved on steel plates. All railroad stocks are required to be issued at a transfer agency and registered at some well-known bank or trust company. This is to prevent a fraudulent over-issue of certificates. The principal New York City banks have the stock exchange telegraph quotations in their banking rooms, and therefore are promptly informed concerning the current fluctuations of the market. On such securities, loans are made usually within ten or fifteen per cent, of the market value. The fluctuations in these stocks thus pledged are carefully watched by a person in the bank, especially appointed for that purpose. It is his duty to demand either more security, or the payment of a part of a loan, in the event of a decline in the value of the security pledged therefor.