A fourth form of bank credit liability that requires protection is Bills Payable. When a bank needs funds and does not find it expedient or possible to discount paper in its portfolio, it may borrow from other banks or financial institutions on its promissory note. Where the practice of rediscounting, either with the central bank or on the open market, is the prevailing banking practice, borrowing by a bank on its note is unusual. In contrast with European practice, where a broad discount market has been developed, the practice of the American banking system has been quite provincial. The common method in the United States has been for a bank to borrow either on its own unsecured note or its note secured by pledge of commercial paper or - sometimes - securities. By this method the paper need not be indorsed, and the creditor protects himself by insisting upon a liberal margin of safety. Loans of this kind are usually seasonal or arise in tight money periods. A bank which borrows, in this way generally carries a good balance with the creditor bank during the rest of the year, and thus establishes friendly relations and a potential "line of accommodation." Interbank borrowings of this sort tend to the maximum utilization of the country's funds and the equalization of money rates both in place and time. The loans are more often time loans than call loans.
During the war the sudden demands upon the banks occasioned by large payments of taxes or subscriptions to loans made it necessary to provide an easy method of negotiating interbank loans. The federal reserve banks were authorized to loan to member banks on their bills payable secured by government securities. This practice became very common and quite largely supplanted the rediscount method.
The state has less occasion to supervise and regulate operations in bills payable than in any other form of bank credit, the reasons being that such bills are relatively small, are occasional, and are between banking institutions, which may be presumed to guard themselves well. By indirection such borrowing may be curtailed, for, as in the case of other loans, the state may limit the liability to any one creditor bank to a percentage of the total assets of that bank. A particular instance where regulation is necessary to prevent the pyramiding of fictitious credits arises when a bank borrows from subsidiaries or branches, or vice versa.
There are at least three variations of this method of incurring liabilities on the bank's promissory note, which are as follows:
1. The borrowing bank may issue to the creditor bank a demand or time certificate of deposit, in which case the Deposits liability is increased rather than the Bills Payable, although the difference between the two is then nominal.
2. The borrowing bank may overdraw its account with its correspondent, which, if it honors the draft, becomes a creditor by the amount of the overdrawal; the overdraft may be secured by pledged collateral or may be unsecured, and is primarily a loan.
3. The borrowing bank may get its check certified for an amount in excess of its balance; while the overcertified check is in circulation the certifying bank is a creditor of the borrowing bank.
The state usually regards these three forms of borrowing in the light of loans and so classifies them. Overdrawing, and particularly overcertifying, are practices that are often prohibited because they represent loose business methods with their attendant danger.