This section is from the "Practical Banking" book, by Albert S. Bolles.
* This portion of the chapter, to page 58, is from the pen of George Walker, concerning whom proper mention is made in the preface of this work.
To reduce it to a definition or formula, I should say that the first and most important function of a bank is, by the use of the capital which it controls, to bridge over the periods of credit which necessarily intervene between production and consumption, in such a manner as to give back to each producer, or middleman, as quickly as possible, the capital invested by him in such products, in order that he may use it over again in new production or new purchases. In this way the interruption of business, which would be a public, as well as a private loss, is avoided. Thus defined, banking is not only one of the most useful, but it is also one of the most safe and healthy of business operations. Its safety lies in the fact that every loan of the character described, is based on property of intrinsic value; and it is the property which, in the last resort, pays all the loans predicated upon it in its progress of transmission from the producer to the consumer. It gathers value as it goes, by the addition of all intervening profits incident to handling and resale, and on final sale the consumer pays the first cost and all those profits added to it. This, of course, is on the supposition that the transactions have been fairly profitable. In the case supposed the property has been the real debtor throughout, and the real payer of the discounts. It has purchased the paper which was the subject of each discount in succession, and has finally been exchanged with consumer for the cash which, in effect, pays them all. The several makers of the paper, though debtors in form, are only insurers, or guarantors, in fact. They pledge their respective property to the payment of the loans; but the primary and generally sufficient pledge is the property for which the notes are given. The wealth of the makers is a necessary margin or guaranty, because the property sold may be destroyed, or the value may fall, or some one of its successive holders may, by misfortune or fraud, divert its proceeds from their legitimate application, namely, payment to the last seller. In a great majority of cases, however, no such contingency happens, and the guaranty is not resorted to. The intervening profits are an additional safeguard, inasmuch as each party, when he sells, ought to receive a larger note than he gave when he bought the goods.
From this analysis of the origin of bank discounts it will be seen that the common maxim among bankers—that the safest loans are on mercantile paper—is not only justified by experience, but rests upon the simplest and clearest scientific principles.
In the reign of the first Napoleon, France had a very enlightened finance minister in M. Mollien. In advising the emperor as to the proper administration of the Bank of France, Mollien laid great stress upon the principles which I have just enunciated. "He undertook to show that no discount is regular, except that of genuine bills of exchange, given in settlement of a completed transaction, in which three parties* have cooperated, and by means of which the acceptor is put in possession of property of actual value, equal to the amount of his acceptance."
"The discount of genuine bills of exchange, which represent the products of labor, which the wants of consumers have called into being, and which their savings are adequate to purchase, ought to be exclusively preferred by banks; it is the real pivot of their organization."
* The three parties are, the drawer, the payee, and the acceptor. When the buyer gives his note instead of a bill of exchange on a third party (as is more frequently the practice in certain parts of this country), the property is pledged indirectly, and only two parties engage in the transaction, while in the case of a bill drawn on the acceptor, who is also the consignee of the property (as is the practice in the cotton, grain, and provision trades), the pledge is specific, and the paper is paid out of the proceeds of sale.
"He reproached the Bank of France with paying too little attention to the discounts of genuine bills of exchange guaranteed by-merchandise in store, which was in demand for consumption, and which the income of the consumers was adequate to pay for."